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    Archive for July, 2010

    The Dodd-Frank Financial Reform Act: A Reader’s Digest Version

    Monday, July 26th, 2010

    A couple of prior posts on this blog (here and here) have explored the economic and regulatory reasons behind 2008’s financial meltdown, while others (here and here) have explored proposed means of handling distressed financial institutions deeemed systemically important to the nation’s financial markets.

    Economic Fears Reignite Market Slump
    Image by YoTuT via Flickr

     

    History and propositions are now overtaken by reform.  Last Wednesday, the Financial Reform Act (aka the Dodd Frank Act) became law.

    Over at Credit Slips, Seton Hall Law Professor Stephen Lubben has offered a very succinct, immediately accessible summary of the Act’s intersection with the US Bankruptcy Code – as well as some helpful links to other, useful material.

    Very important reading for those who want the “bullet points” without wading through the nearly 2,300 pages of legislation.

    Happy reading.

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    The Shadow of Shadow Banking

    Sunday, July 18th, 2010

    A recent post over the July 4 holiday weekend offered a “30,000 foot view” of the 2008 world-wide financial meltdown and offered some broad observations about its causes – and remaining challenges to recovery.

    From the Federal Bank of New York last week comes yet another broad overview – this one of the “shadow banking” system that has come to comprise a significant portion of the US’s (and the world’s) financial infrastructure – particularly that of the world financial markets.

    Looking south from Top of the Rock, New York City
    Image via Wikipedia

     

    In Shadow Banking, researchers Zoltan Pozsar, Tobias Adrian, Adam Ashcraft, and Hayley Boesky describe the financial components of this ad hoc banking system, its role in recent asset bubbles, its brittleness under stress, and the role of the Federal Reserve and other federal agencies in relieving that stress.

    As described in the abstract:

    The rapid growth of the market-based financial system since the mid-1980s changed the nature of financial intermediation in the United States profoundly. Within the market-based financial system, “shadow banks” are particularly important institutions. Shadow banks are financial intermediaries that conduct maturity, credit, and liquidity transformation without access to central bank liquidity or public sector credit guarantees. Examples of shadow banks include finance companies, asset-backed commercial paper (ABCP) conduits, limited-purpose finance companies, structured investment vehicles, credit hedge funds, money market mutual funds, securities lenders, and government-sponsored enterprises.

    Shadow banks are interconnected along a vertically integrated, long intermediation chain, which intermediates credit through a wide range of securitization and secured funding techniques such as ABCP, asset-backed securities, collateralized debt obligations, and repo.

    This intermediation chain binds shadow banks into a network, which is the shadow banking system. The shadow banking system rivals the traditional banking system in the intermediation of credit to households and businesses. Over the past decade, the shadow banking system provided sources of inexpensive funding for credit by converting opaque, risky, long-term assets into money-like and seemingly riskless short-term liabilities. Maturity and credit transformation in the shadow banking system thus contributed significantly to asset bubbles in residential and commercial real estate markets prior to the financial crisis.

    We document that the shadow banking system became severely strained during the financial crisis because, like traditional banks, shadow banks conduct credit, maturity, and liquidity transformation, but unlike traditional financial intermediaries, they lack access to public sources of liquidity, such as the Federal Reserve’s discount window, or public sources of insurance, such as federal deposit insurance.  The liquidity facilities of the Federal Reserve and other government agencies’ guarantee schemes were a direct response to the liquidity and capital shortfalls of shadow banks and, effectively, provided either a backstop to credit intermediation by the shadow banking system or to traditional banks for the exposure to shadow banks.  Our paper documents the institutional features of shadow banks, discusses their economic roles, and analyzes their relation to the traditional banking system.

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    Reflections for a Holiday Weekend: The Great Recession of 2008

    Monday, July 5th, 2010

    Last weekend’s July 4 holiday afforded members of the US business and restructuring community an opportunity for reflection on recent economic history.  Those who took the opportunity to do so would have benefitted from “The Great Recession of 2008-2009: Causes, Consequences and Policy Responses,” a recent discussion paper authored by Sher Verick and Iyanatul Islam and prepared under the auspices of the Institute for the Study of Labor (an independent think-tank associated with the University of Bonn, Germany).

    Assorted international currency notes.
    Image via Wikipedia

     

    According to the authors’ abstract:

    “Starting in mid-2007, the global financial crisis quickly metamorphosed from the bursting of the housing bubble in the US to the worst recession the world has witnessed for over six decades.

    Through an in-depth review of the crisis in terms of the causes, consequences and policy responses, [the] paper identifies four key messages. Firstly, contrary to widely-held perceptions during the boom years before the crisis, the paper underscores that the global economy was by no means as stable as suggested, while at the same time the majority of the world’s poor had benefited insufficiently from stronger economic growth.

    Secondly, there were complex and interlinked factors behind the emergence of the crisis in 2007, namely loose monetary policy, global imbalances, misperception of risk and lax financial regulation.

    Thirdly, beyond the aggregate picture of economic collapse and rising unemployment, this paper stresses that the impact of the crisis is rather diverse, reflecting differences in initial conditions, transmission channels and vulnerabilities of economies, along with the role of government policy in mitigating the downturn.

    Fourthly, while the recovery phase has commenced, a number of risks remain that could derail improvements in economies and hinder efforts to ensure that the recovery is accompanied by job creation. These risks pertain in particular to the challenges of dealing with public debt and continuing global imbalances.”

    Verick and Islam’s work offers an excellent overview for anyone seeking to view economic events of the last two years through a “wide-angle” lens.

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